NY futures ended the week slightly lower, as March gave back 75 points to close at 81.88 cents.

The market has started to pull back this week, in what still looks like a correction in a bullish trend at this point. The market has been long overdue for a pullback, after it had posted thirteen consecutive higher weekly lows and open interest grew by nearly 95k contracts since November 15.

Even though prices didn’t move much this week, the average daily volume amounted to almost 42k contracts and open interest climbed to a new record of 319,205 contracts (=31.92 million bales) yesterday, an increase of over 10k since last week.

This means that the two opposing forces have grown even bigger this week and we now have a near record spec net long position squaring off with a near record trade net short. Based on the latest CFTC spec/hedge report as of January 16, the outright trade short of 26.03 million bales was the largest since early November 2010, while the trade net short position of 18.72 million bales is still comparable to what we had a year ago.

Last season the trade net short position reached 19.59 million bales on February 14, when the March contract was at 76 cents. From there the market would trade in the high 70s and low 80s until prices spiked to a high of 87.18 cents on May 15. Interestingly, the trade net short position was still at 17.76 million bales when the market peaked and only started to come down once spec longs liquidated nearly eight million bales over the following six weeks, with prices dropping back to the low 70s.

In other words, the trade short was able to keep the upper hand against the mighty spec long last season, which may give the trade some confidence that it can be done again, especially since there is quite a bit more cotton available around the globe this season. However, the amount of unfixed on-call sales on March, May and July is 1.9 million bales larger this season, which makes the trade’s endeavor a bit more difficult.

The latest CFTC on-call report showed that as of last Friday there were still 3.84 million bales to be fixed on March, along with 3.58 million on May and 3.89 million bales on July, for a total of 11.31 million bales of current crop fixations. This compares to 3.55, 2.91 and 2.95 million bales for a total of 9.41 million bales a year ago.

The trade believes in lower prices based on fundamentals, as cash cotton and yarn prices are struggling to follow the lead of the futures market. Speculators on the other hand feel that this cotton bull isn’t going to falter anytime soon due to a weakening US dollar, strong demand, higher inflation expectations and commodities being the most undervalued compared to equity markets in four decades.

So where do we go from here? The market is setting up for another epic showdown between spec longs and trade shorts and at this point it is still anybody’s guess who will prevail. Like last year this could turn into a drawn-out process, with prices moving in a narrow band for another two or three months before a final blow off and/or collapse occurs.

One thing that could work in favor of the trade is that the ascent of this bull move has been quite steep and quick, which means that it doesn’t take much of a sideways or down movement to start crossing moving averages and trend lines, which could then trigger spec long liquidation.

Specs on the other hand are trying to force the trade into covering their shorts, which could lead to an explosive move. In order to achieve that specs don’t even have to buy any more longs, they just have to sit on the ones they already own. Since the trade needs to get out of shorts over the coming months due to fixations and sales of basis-long positions, it would generate enough buying to move prices higher.

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